Degrees of Debt: Shedding Student Loans in Bankruptcy Is an Uphill ...

Ty William Wright for The New York Times

Doug Wallace Jr., 33, at his father?s home in Plain City, Ohio, with? his father, Doug, his younger sister, Megan, and his nephew Scott.

PLAIN CITY, Ohio ? It isn?t easy to stand up in an open courtroom and bear witness to the abject wretchedness of your financial situation, but by the time Doug Wallace Jr. was 31 years old, he didn?t have much left to lose by trying.

Diabetes had rendered him legally blind and unemployed just a few years after graduating from Eastern Kentucky University. He filed for bankruptcy protection and quickly got rid of thousands of dollars of medical and other debt.

But his $89,000 in student loans were another story. Federal bankruptcy law requires those who wish to erase that debt to prove that repaying it will cause an ?undue hardship.? And one component of that test is often convincing a federal judge that there is a ?certainty of hopelessness? to their financial lives for much of the repayment period.

?It?s like you?re not worth much in society,? Mr. Wallace said.

Nevertheless, Mr. Wallace made his case. And on Wednesday, nearly six years after he first filed for bankruptcy, he may finally get a signal as to whether his situation is sufficiently bleak to merit the cancellation of his loans.

The gantlet he has run so far is so forbidding that a large majority of bankrupt people do not attempt it. Yet for a small number of debtors like Mr. Wallace who persist, some academic research shows there may be a reasonable shot at shedding at least part of their debt. So they try.

Before the mid-1970s, debtors were able to get rid of student loans in bankruptcy court just as they could credit card debt or auto loans. But after scattered reports of new doctors and lawyers filing for bankruptcy and wiping away their student debt, resentful members of Congress changed the law in 1976.

In an effort to protect the taxpayer money that is on the line every time a student or parent signs for a new federal loan, Congress toughened the law again in 1990 and again in 1998. In 2005, for-profit companies that lend money to students persuaded Congress to extend the same rules to their private loans.

But with each change, lawmakers never defined what debtors had to do to prove that their financial hardship was ?undue.? Instead, federal bankruptcy judges have spent years struggling to do it themselves.

Most have settled on something called the Brunner test, named after a case that laid out a three-pronged standard for judges to use when determining whether they should discharge someone?s student loan debt. It calls on judges to examine whether debtors have made a good-faith effort to repay their debt by trying to find a job, earning as much as they can and minimizing expenses. Then comes an examination of a debtor?s budget, with an allowance for a ?minimal? standard of living that generally does not allow for much beyond basics like food, shelter and health insurance plus some inexpensive recreation.

The third prong, which looks at a debtor?s future prospects during the loan repayment period, has proved to be especially squirm-inducing for bankruptcy judges because it puts them in the prediction business. This has only been complicated by the fact that many federal judicial circuits have established the ?certainty of hopelessness? test that Mr. Wallace must pass in Ohio.

Lawyers sometimes joke about the impossibility of getting over this high bar, even as they stand in front of judges. ?What I say to the judge is that as long as we?ve got a lottery, there is no certainty of hopelessness,? said William Brewer Jr., a bankruptcy attorney in Raleigh, N.C. ?They smile, and then they rule against you.?

Debtors themselves struggle with testifying in their undue hardship cases. Carol Kenner, who spent 18 years working as a federal bankruptcy judge in Massachusetts before becoming a lawyer for the National Consumer Law Center, said that one particular case stuck in her mind.

The debtor had a history of hospitalization for mental illness but testified that she did not suffer from depression at all. ?She was so mortified about the desperation of her situation that she was committing perjury on the stand,? Ms. Kenner said. ?It just blew me away. That?s the craziness that this system brings us to.?

Debtors also stretch the truth in other directions. In 2008, a federal bankruptcy judge in the Northern District of Georgia expressed barely disguised disgust in deciding a case involving a 32-year-old, Mercedes-driving federal public defender with degrees from Yale and Georgetown. With nearly $114,000 in total household income, the woman?s financial situation was far from hopeless, despite her $172,000 in student loan debt.

No one keeps track of how many people bring undue hardship cases each year, but it appears to be under 1,000, far less than the number of people failing to make their student loan payments. In its most recent snapshot of student loan defaults, the Department of Education reported that among the more than 3.6 million borrowers who entered repayment from Oct. 1, 2008, to Sept. 30, 2009, more than 320,000? had fallen behind in their? payments by 360 days or more? by the end of September 2010. About 10.3 million students and their parents borrowed money under the federal student loan program during the 2010-11 school year.

Andrew Martin contributed reporting.

Source: http://g7finance.com/g7finance-news/degrees-of-debt-shedding-student-loans-in-bankruptcy-is-an-uphill-battle/

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